There’s more to China’s tumbling metals prices than spooked speculators

RachelKoning Beals

A Chinese worker in a steel mill in Hefei, in eastern China's Anhui province.

A price retreat in Chinese markets for rough metals, including iron ore, steel, and reinforcing steel, or rebar, likely reflects deeper growth concerns for the world’s second-largest economy, not just short-term market machinations, said analysts.

Similar indications emerged in a weekend release of Chinese economic data.

“China released a raft of data that reignites doubts about the nation’s economic stabilization. Fixed asset investment, retail sales and industrial production all missed expectations and slowed in April, suggesting that the upbeat March prints were not descriptive of the underlying trend in economic activity,” said Charalambos Pissouros, senior analyst at IronFX global.

Before that data hit, flares had already gone up in the base-metals futures markets. Last week, they went into full retreat. Iron-ore futures and steel-rebar futures on the Shanghai Futures Exchange and the Dalian Commodity Exchange both dropped 13% and hot-rolled coil fell 12%, which left them all down around 25% since a 2016 rally peaked on April 21. In fact, rebar futures posted their biggest weekly loss in at least seven years, analysts at Commerzbank noted.

It was challenging to separate short-term market phenomena — including relatively new interest from speculators in this space and fresh exchange-mandated trading rules — from the true fundamental picture. Speculative funds scurried into Chinese commodity futures in April in particular amid signs that the economic slowdown was bottoming. In response, the country’s three commodity exchanges raised trading margin requirements and transaction fees, and widened daily movement limits.

China’s steel and iron-ore trading, long carried out in intimate deals between major industrial users, has turned into a speculative-trading draw. About $330 billion of iron-ore futures traded on the Dalian exchange in April, more than double the monthly turnover as recently as February.

Ciaran Roe, a Platt’s analyst, in a blog post from late April, noted the expansion of market chatter to industrial-use metals in much the same way that speculators created buzz — and an eventual bubble some would argue — in equities in China last year.

It is activity that can muddle what’s really driving the market. “All the while China keeps telling us how strong it is, but their usage numbers as of late, are proving to be very significant to me, as my first number-crunching review of the last batch of numbers released from China showed a 7% lowering in base metals usage (YTD),” said Peter Thomas, senior vice president, precious metals, at Zaner, in a commentary. “Something is going on in the Silk Road area, and they aren’t sharing it with us.”

For one thing, inventories appear to be building. Data showed iron-ore inventories held at ports across China increased 1.4% to the highest since March 2015, according to data from Shanghai Steelhome Information Technology Co., while rebar stockpiles rose for the first time in nine weeks.

It’s taken a toll on industry sentiment. A majority of Chinese steel market participants believe prices will likely fall over the next month due to weaker domestic demand, with the outlook for construction steel particularly bleak, according to the S&P Global Platts China Steel Sentiment Index (CSSI) released May 9; it showed a headline reading of 46.98 out of a possible 100 points in May. A reading above 50 indicates expectations of an increase/expansion and a reading below 50 indicates a decrease/contraction.

Platts

Overcapacity in China’s steel industry is not yet falling, a vice minister said on Monday, according to Reuters and other news outlets, as the country’s leading steel companies conceded that current output was unsustainable and blamed the restart of mills previously shut.

Meanwhile, China is facing tough calls for trade penalties to block its exports by global rivals, who say it is dumping cheap metals exports after a slowdown in demand at home. China is the world’s biggest steel producer and had vowed to cut production capacity by 100 to 150 million metric tons over five years from around 1.1 billion metric tons The recovery in domestic steel prices earlier this year has complicated the pledged export cuts.

As for the bigger picture, bullish speculators and industry participants could continue to pick out the bright spots in China’s economic outlook, which could be needed to steady volatile base-metals markets.

“Policy-makers appear to be shifting their focus away from short-run growth concerns back to addressing medium-term risks and so we don’t expect any major policy easing during the remainder of this year,” said Julian Evans-Pritchard, China economist at Capital Economics. “But with the impact of earlier policy loosening yet to be fully felt, we think there is enough stimulus already in the pipeline to support [an economic] recovery until the end of the year.”

For many analysts, the demand picture is cloudy at best, especially in construction. “Although we expect strong sales, 2016 will be a year of destocking. Developers have been tasked by the Chinese government with running down property inventory, particularly in smaller, provincial cities. This means that construction activity should be much lower than sales this year and thus a drag on commodity demand,” said Colin Hamilton, Macquarie Group’s global head of commodities research, in a late-April published commentary.

A U-turn in the government approach to property activity could alter that outlook.

Still, “we do not think the overarching challenges in commodity markets are set to significantly diminish. While demand for commodity-containing goods may be good, and certainly better than 2015 owing to destocking, raw commodity demand will not [be],” Hamilton said.

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